PE liquidity at all time low amid macro woes – Rede Partners

Based on LPs’ liquidity predictions for the year ahead, the survey records whether investors are expecting to increase, decrease or maintain their private equity commitments.

The RLI fell from 55 in the H1 2022 edition to 41 in the current edition, marking the lowest score on record. This score means that LPs are on average planning to decrease their allocation to PE in the next 12 months, with over a third (35%) of institutional investors specifically planning to decrease this allocation.

Distribution expectations have also reached a new low, dropping from 33 in 1H22 to 11 in 2H22. This reflects the challenges in realising private equity returns via exits, with 84% of LPs overall expecting a reduction in distributions.

Much of this is down to the challenging macroeconomic uncertainty, making for a tough PE exit environment as valuation expectations adjust, financing becomes more challenging, and companies come under pressure from inflation.

Breathe and reflect
Although LPs are naturally worried about the situation, Gabrielle Joseph, head of due diligence and client development at Rede Partners, told Unquote that it is "not all doom and gloom".

"At the end of last year, the RLI was showing that we were getting to an unsustainable boom in fundraising," she said. "The system is set up to cope with fundraising on a two to three and a half year basis, and once we got down to an 18-month cycle, with fund size scaling, platform extensions, GP-leds and co-invests, the system was stretched to breaking point."

Joseph expects to see a "natural process in which the market will adapt" in the coming year. Given that many GPs took advantage of the advantageous market conditions in 2021 to raise their funds, the market is likely to be less crowded. Fundraising cycles are expanding again, she noted, and dealmaking is slowing.

"We will have fewer GPs needing to fundraise next year, and some will moderate their fund size target expectation," she said. "There will be a natural calibration to avoid a total hard stop to fundraising – it will be a moment to breathe and reflect."

Shifting preferences
LP preferences are also shifting in this environment. According to the survey, one third of LPs intend to increase their exposure to lower mid-market buyout funds in the next 12 months, and almost as many (31%) want to increase their exposure to mid-market funds.

Healthcare is also faring well, with 30% of LPs intending to increase their allocation to funds focuses on this sector.

On the other hand, strategies typically exposed to technology and minority participations are more likely to suffer. Just 13% of LPs intend to increase their exposure to venture, while 14% plan to increase their exposure to growth capital, versus 26% who expressed an intention to do this six months ago.

LPs are still approaching new relationships with caution against macroeconomic uncertainty and their own liquidity constraints. The previous edition of the index revealed that a record number of LPs were cutting their “new money” commitments, narrowing down their new manager relationships, as reported. The latest edition reveals that this number has fallen even lower, from 45 to 39.

Impact in focus
Impact funds are moving up investors' agendas, with 21% of the LPs surveyed saying that they plan to increase their exposure to impact and sustainability strategies, versus 17% in the previous survey. This appetite has been strongest in Europe, Joseph noted, but LPs in the US are moving in the same direction.

"We’re seeing an increasing acceptance that the climate change mitigation megatrend will be the second major investment theme of the 21st century, following digitalisation," Joseph said. This is leading to "a real step change" in the amount of value placed on companies involved with mitigating the climate crisis.

Joseph cites funds including Summa Equity, who are "delivering outstanding exits and posting really good results."

Social impact is also a focus for LPs, Joseph said. Investors are thinking about what matters most to their stakeholders, which is diversified across regions, she noted.

The 2H22 RLI collected responses from 115 LPs globally, with EUR 5trn in AUM and EUR 850bn in private equity allocations.

Getting creative
Rede Partners said in a press release that it expects the current environment to lead to more “creative approaches to boosting liquidity”, including partial exits, GP-led secondaries and NAV financing.

When it comes to fundraising, options available to GPs looking to get creative in attracting LPs include co-investment access and favourable fund term adjustments.

This will not be appropriate in every case, however. "You can’t stand out as a compelling investment opportunity just by offering carrots to LPs," Joseph said. "Having a compelling and unique investment offer is the number one reason for success."

These potential LP incentives are not yet materialising in the market, she noted. "We’re not seeing huge fund term discounts like we did after the GFC, and offering this isn’t always the best signal to LPs. Co-investing remains a major area of interest to LPs, and this remains a high quality tool, but GPs should not offer it if their strategy does not lend itself to this."

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